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A tempting offer

A tempting offer

A Guide to: EMI – Employment Management Incentives

In Summary

Heather Tulloch, Senior Manager/Consultant

heather.tulloch@ashcroftllp.com

7 September 2021

Employee share ownership helps to align the interests of a company’s owners with that of employees.

An employee who sees potential through sale of shares may join a company, even if the cash salary is less than that on offer from larger companies.

There are a number of conditions which must be met before EMI options can be issued. When the EMI conditions are not met “unapproved” share options can be used

Employee share option schemes – EMI v unapproved

The range of benefits used to motivate and retain employees has become increasingly diverse and creative in recent years, however when it comes to incentivising key members of the team one of the most effective benefits has remained the grant of company share options. This offers these crucial individuals the chance to own a small part of the company and therefore become truly invested in the performance of the business, with minimal upfront costs. Employee share ownership helps to align the interests of a company’s owners with that of employees. All are looking to increase shareholder value through growing the business, in the hope that they will eventually benefit through sale of their shares or through receiving dividends.

Share options can be particularly useful for new businesses who may not be able to compete on salary but are expecting high growth such that share options can be used to tempt in talent. An employee who sees potential for realising a significant lump sum through sale of shares may well be persuaded to join a company, even if the cash salary is less than that on offer from larger companies.

The most well-known type of options is Employment Management Incentives, or EMIs. These come with generous tax benefits but can only be used in certain circumstances. When the EMI conditions are not met “unapproved” share options can be used – whilst these don’t have the same beneficial tax treatment, they are more flexible and therefore should not be overlooked.

EMI options – tax treatment

If the exercise price of an EMI option is at least equal to the market value of the shares at the date of grant, and the options are exercisable within 10 years, then no income tax or National Insurance Contributions (NICs) are due at the date of grant, or at the date of exercise.

If an employee exercises an EMI options and later sells the shares then Capital Gains Tax (CGT) would normally be due. Gains on shares acquired via EMI options can be eligible for Business Asset Disposal Relief (BADR, formerly known as Entrepreneurs Relief) provided that the individual has been an employee and held the options for at least 2 years prior to the sale. Therefore, ER can available even if the individual does not hold the 5% interest, which would otherwise normally be required in order to qualify.

It is possible to issue EMI options with an exercise price below the market value at the date of grant, however income tax will be due on the difference between the exercise price and the market value at the date of the grant. This tax charge will arise when the options are exercised. If the shares are quoted or readily convertible into cash the employer is required to operate PAYE on the taxable amount and NICs will also be due.

As you can see the market value at the date of the grant is crucial with EMI options. Fortunately, there is a mechanism to agree this value with HMRC before the options are issued, and we would be happy to assist with this.

EMI options – conditions

There are a number of conditions which must be met before EMI options can be issued.  These apply both to the issuing company and the employees:

  • The company must not be under the control of another company, it must be trading wholly or mainly in the UK and have gross assets not exceeding £30 million and no more than the equivalent of 250 full-time employees. Group of companies can issue options in the parent company to employees of any company within the group provided all companies within the group qualify and the group assets do not exceed £30 million.
  • EMI options can be granted to any employee who controls 30% or less of the ordinary share capital of the company and works for the company for at least 25 hours a week (or 75% of their working time if less than 25 hours). Each employee can receive options worth up to £250,000 at the date of grant.
  • The shares must be ordinary shares but can have restricted voting rights or a qualifying hurdle.
  • It is possible to agree the value of EMI shares with HMRC and apply for advanced assurance that the company meets the EMI qualifying conditions and can issue EMI options in advance of granting the options in order to reassure employees that the favourable tax treatment will be available.

Unapproved options – tax treatment

There is also no income tax due on the grant on an unapproved share option. However, the tax due on the exercise of an unapproved option will typically be higher as it is based on the difference between the exercise price and the market value at the date of exercise (as opposed to market value at the date of grant as for EMI options).

The CGT base cost of the shares will be the aggregate of the exercise price and the amount on which tax is paid, i.e. the market value at the date of exercise. Therefore, when the shares are sold soon after exercise, it is likely that there will be minimal or no CGT due on the sale.

Where the shares are sold at a later date the normal CGT rules apply and as such the gain will only be eligible for BADR if the 5% interest, and other conditions, are met.

Flexibility of unapproved options

There are no restrictions on the types of company which can issue unapproved options, or on the employees that can be issued unapproved options. Furthermore, it is possible to issue unapproved options to different employees with different exercise prices, meaning that they can be tailored to specific key members of the team.

Corporation Tax Deduction

Share option schemes have a further benefit for employers. In the accounting year that the options are exercised the company can claim a corporation tax deduction equal to the difference between the market value of the shares and the exercise price paid by the employees. For unapproved schemes this deduction will be equal to the amounts charged to income tax on the employees, but EMI options benefit from the corporation tax deduction in addition to the favourable income tax treatment.

Reporting requirements

Regardless of the type of options issued these are Employment Related Securities (ERS) and as such an annual return will be required for each tax year in which an option scheme is open. These returns must be submitted to HMRC online by the 6 July following the end of the tax year.

Given the tax benefits associated with EMI options there are additional reporting requirements. Any grants of options must be notified to HMRC within 92 days, and the scheme must be registered with HMRC before this notification can be made. If this notification is missed the options will not be EMI options and will lose their tax advantaged status so it is crucial that this report is made in a timely manner.

Summary

 EMI optionsUnapproved options
Tax on employee at grantNilNil
Tax on employee at exerciseIncome tax on difference between exercise price and market value at date of grant, if any.Income tax on difference between exercise price and market value at date of exercise.
CGT – base cost of shares for employeeMarket value at date of grantMarket value at date of exercise
CGT due on sale5% shareholding not required in order to qualify for ER, provided the other conditions are metNormal rules apply, ER only available if hold at least 5% and all other conditions met
Maximum value of options to be issued to each employee£250,000 (£3m for the whole of the company)N/A
Company/group size limitGross assets of £30 millionN/A
Maximum number of employees250N/A
Reporting requirementNotification within 92 days Annual ERS returnAnnual ERS return
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